Deregulation is flavour of the season, but caution needed in banking

In a year in which India has been hit with additional tariffs of 50 per cent on exports to the United States, you would not have expected India’s gross domestic product (GDP) growth projection to be revised upwards from 6.5 per cent in April to 6.8 per cent in October. Or the inflation rate to be revised downwards from 4.0 per cent to 2.6 per cent. 

Yet, that is what the Reserve Bank of India (RBI) did in its latest monetary policy statement earlier this month. The tariffs will indeed impact growth. However, since they kicked in from September, the impact will be felt in the third and fourth quarters. The RBI’s downward revisions for these two quarters indicate the impact will be extremely modest. For the year as a whole, the impact of tariffs in the second half of the year is overshadowed by GDP growth of 7.8 per cent in the first quarter of FY26, which was a good 100 basis points (bps) above expectations. 

Commentators have been crying gloom and doom for the Indian economy ever since Donald Trump’s announcement of reciprocal tariffs on “Liberation Day”, April 2. Little of that has materialised in all these months. Analysts were projecting India’s GDP for FY26 to be shaved by around 50 bps, from 6.5 per cent to 6 per cent or below. The RBI believes nothing of the sort is on the cards. 

But then the Indian economy has a habit of delivering pleasant surprises in recent years. In FY23, a year in which the Ukraine conflict erupted and unfolded in a big way, India’s GDP grew at 7.6 per cent when analysts were unsure if growth of even 6.5 per cent was possible. In FY24, GDP growth shot up further to 9.2 per cent, a number that defied all forecasts by a wide margin.   

These outcomes cannot be said to be accidental. They are the result of sound macroeconomic policies, regulation, and governance. The economy has become resilient in the face of serious challenges. 

What we are faced with at the moment is uncertainty. We do not know exactly how the tariffs will unfold, where they will settle, or when. Geopolitical shocks have thus far not spiralled out of control but nobody can bet on that. The answer is not “big bang” reforms, dramatic measures that exacerbate uncertainty in the present while promising returns in the distant future. Instead, the focus must be on reducing uncertainty in the present while creating a more enabling environment for economic agents. The government is right in moving deregulation to the top of its agenda, even as it maintains the momentum of public investment.  

That also appears to be the thinking behind the stance of the RBI in its latest monetary policy statement. With inflation at a record low, there seemed to be little risk in cutting the policy rate. The RBI resisted the temptation to do so. With a projected growth rate of 6.8 per cent in a challenging environment, there is not much upside to be had from cutting the policy rate at this point. Better to conserve ammunition for when the growth rate threatens to sag.  

The RBI has instead announced deregulatory measures that are intended to boost credit growth at banks. Bank non-food credit has grown at 10.2 per cent over the previous year, down from 13 per cent in the year before. It is driven mostly by growth in consumer loans (11.8 per cent). Loan growth to industry is a disappointing 6.5 per cent and it is propped up by growth in loans to micro, small and medium enterprises (18.5 per cent), once regarded as a problem area by banks. Growth in loans to large corporations is a mere 1.8 per cent. 

The RBI says that industry is taken care of by funds from non-bank sources. In 2025-26, the total flow of resources from non-bank sources to the commercial sector increased by ₹2.66 trillion, more than offsetting the decline in non-food bank credit by ₹0.48 trillion.  One does not know why the RBI is coy about providing the figures for the flow of funds from different sources (banks, non-banks, external commercial borrowings, internal resources, etc), as it used to in the past.  

The deregulatory measures are about growing banks’ loan business at the expense of competing sources. The big deregulatory move is allowing banks to fund mergers and acquisitions (M&As). This is long-term funding that entails asset-liability mismatches. It also requires care in judging valuations of M&As. The RBI might have allowed such financing for the better-rated banks to start with and then extended it to the lower-rated banks.  

Another deregulatory move is the removal of the framework that disincentivised lending to corporations with bank credit exposure of over ₹10,000 crore. The RBI argues that the Large Exposure Framework suffices to manage risk at the bank level. The issue of lending to highly leveraged corporations, however, does not go away. As we all know, banks lent merrily to a high-profile, highly leveraged group. It required the shock effect of an equity research report for the group to bring its leverage down to more sensible levels.  

The RBI says it will address concentration risk through macro-prudential tools if necessary. Presumably, it does not see a problem of high leverage at corporations at the moment. Nevertheless, there is merit in specifying higher risk weights for bank loans to corporations with debt-to-equity ratio above a certain level (instead of specifying an absolute value of credit exposure). A third regulatory move — a proposal to license new urban cooperative banks — is truly mystifying.  

The deregulatory measures will boost credit growth and bank income but will not boost economic growth because, for the most part, they substitute non-bank credit with bank credit. It is not clear that low rates of credit growth are a serious problem for banks at the moment. Return on assets of scheduled commercial banks was a healthy 1.4 per cent in March 2025; for public sector banks, it was 1.1 per cent. Besides, banks continue to face the problem of deposit growth lagging credit growth: Deposits grew at 9.5 per cent in the last year while credit grew at over 10 per cent. Boosting credit growth without getting a handle on deposit growth is not a great idea.  

Deregulation in the economy in general is a good thing. There is always a case for visiting regulations that have outlived their rationale and cramp business activity. In banking, however, it is wise to make haste slowly with deregulatory initiatives. Bank governance and risk management still have a long way to go. It makes sense to conserve the hard-won gains of financial stability of the past few years. 

 

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